Buy-to-let landlords are artificially boosted by tax breaks that deliver a taxpayer subsidy of up to £5.2bn for their investments, a new report has claimed.

The long-standing ability to offset mortgage interest payments and wear and tear against income tax bills on rent, combined with the loopholes that allow many to avoid paying capital gains tax, have been branded an ‘upper middle-class perk’ by an Intergenerational Foundation report.

Ed Howker, of the campaign group, said: ‘Britain has spent more than a decade encouraging a form of housing investment that builds very few new homes, rinses the taxman, raises the cost of housing and prices-out first-time buyers.’

Skewing the market: Buy-to-let investment have pushed up house prices and encouraged the building of flats not houses, the Intergenerational Foundation says.

The situation is doubly unfair, according to the report’s authors, as much of the benefits from buy-to-let tax breaks go to an older, wealthier generation that has already reaped large gains from high house price inflation.

In addition, the system has further pushed up house prices, disadvantaged first-time buyers and families attempting to move up the property ladder and led to the building of too many flats rather than the houses owner occupiers want and Britain needs, report author David Kingman argues.

It said that justifying bumper tax breaks for buy-to-let landlords on the basis that they are running a business was flawed and it should actually be classified as an investment.

The reported added that HMRC even ‘classifies rent as unearned income’, delivering a basis for this change.

On the other hand landlords argue that they provide much-needed homes for tenants to rent and paying tax on mortgage interest would override the general principle of only taxing profit not overall turnover.

The biggest chunk of buy-to-let tax breaks go on mortgage interest, which landlords are able to offset against the rent they are paid for income tax.

This is a luxury not enjoyed by private homeowners since MIRAS, as Mortgage Interest Relief at Source was dubbed, was axed by Gordon Brown, having already heavily hacked back at the end of the 1980s.

Landlords can also automatically claim 10 per cent a year of rent as a wear and tear allowance, without having to prove they have spent the money.

Letting agents fees, ground rent, insurance, accountants fees and even utility bills and council tax if paid by the landlords, are among other items that can also be claimed against tax each year.

A Freedom of Information Act request found that in 2010 to 2011, landlords deducted £13bn against income tax, at the upper end of estimations based on a 40 per cent tax rate, this meant £5.2billion in lost revenue. At the lower end, based on a 20 per cent tax rate, £2.6bn was missed out on.

The mortgage interest tax break on buy-to-let has long been controversial, and is justified as an encouragement to private investors to put money into buy-to-let and provide the stock of rental homes the nation needs.

It treats them in the same way that a business owner would be treated, meaning that they are only paying tax on rental profits rather than the cost of servicing mortgages.

HOW INTEREST CUTS TAX BILLS

A landlord with a £150,000 interest-only
mortgage at a 5 per cent interest rate could set their monthly payments
of £625 against rental income of £1,000 and only pay tax on £375 per
month.

Critics argue this is overly generous and puts private owners at a disadvantage, however, an unintended consequence of removing it could be an across the board rise in rents as landlords hike prices to stop their profits being slashed.

Property investors should also pay capital gains tax on the profit they make when they sell, however, those who have become landlords by letting homes they previously lived in can typically slash their bill for this.

Owner occupiers do not have to pay capital gains tax on their home, which is officially termed their principal private residence.

Second homes do incur the tax, but an exemption means that if at any point that property has been its owners’ only or main residence, the last 36 months of ownership qualify for private residence relief and that period of ownership does not incur CGT.

The report’s author David Kingman said: ‘Landlords only need to live in their property for a relatively short period of time in order for it be exempt from capital gains tax for the next three years – possibly for as little as six months.

‘Also, they can justify it as a main residence relatively easily, for example by providing utility bills which list it as their main address, or being registered on the electoral register there.‘

Unmarried couples can each designate a separate property as their main residence.

CGT is levied at 18 per cent 28 per cent depending on whether people are basic rate or higher rate taxpayers, however, gains are added to income to deliver a total amount that decides this. This means that in practice most landlords making decent profits should pay the 28 per cent rate.

A further element called lettings relief can further reduce capital gains tax, which combined with the annual £10,900 CGT allowance can often take bills down to zero.

Letting relief is worth the lowest of three amounts: private residence relief already claimed, the value of the increase in capital gains which occurred during the period when the property was being let, or £40,000.

Furthermore, investors can also offset stamp duty and estate agents' fees against their CGT liability.

HOW TO PAY NO TAX ON A £123,000 PROFIT

Arthur bought a flat in South London
for £100,000 and sold a decade later for £223,000.
This means he made a gain of £123,000 and, in theory, at 28 per cent would
have a CGT liability of £34,500 - here is how the current system allows
him to take it down to nothing.

He lived in the property for the first three years and then rented it out for the remaining seven.

For tax purposes, capital gains are
assumed to have accrued equally throughout the period of ownership, so
Arthur officially made gains of £12,300 per year.

The capital gains which accrued
during the first three years qualify for private residence relief, in
addition to the gains during the final three years (because of the 36
month rule), so this keeps £73,800 way from CGT.

That leaves £49,200 worth of gains during the first four years when the flat was rented out.

Arthur can then claim letting relief,
which would be worth £40,000 (because this is the lowest of the three
elements: the amount of private residence relief already claimed of
£73,800; the gains which occurred during the period of £49,200; or
£40,000.

Now the sum on which capital gains tax would be liable is just £9,200, but this can also be removed if Arthur has a wife or partner who owns
the property with him and can also claim £40,000 worth of letting
relief.

If not he could simply use his £10,900 a year capital gains tax
allowance, as long as he hasn’t made any other gains that year.

The tax system is unjust, Mr Howker argued, and has underpinned the meteoric rise of buy-to-let investment and driven house price inflation higher.

He said: ‘Economically, buy-to-let investors should not imagine they are small-business owners. They are much less useful to the economy, rarely employing anyone who would not be employed by owner-occupiers to service their homes and deriving their income from gambling on house price rises.

‘Simply because these speculations have, in recent years, paid off does not make them the work of proper business.’